Investment-Grade Corporate Bonds: Walking the Tightrope
Demand for investment-grade corporate bonds should remain strong.
Investment-grade corporate bond gross issuance was heavy in the third quarter, with September’s total issuance of $148 billion making it the biggest September and fifth largest month on record. Despite the heavy volume of primary supply, geopolitical tensions, escalating recession fears, and strong technical factors combined to help investment-grade corporate bond spreads end the third quarter only 2.5 basis points wider than the end of the second quarter. The yield on the Bloomberg Global Investment-Grade Corporate Bond index decreased to 2.91 percent from 3.17 percent over the same timeframe, resulting in 13.0 percent year-to-date total return.
Corporate spreads found technical support from steady investment-grade corporate bond fund inflows, net supply dynamics, foreign demand for 30-year corporates, and a buildup of cash from domestic buyers. According to EPFR fund data, investment-grade fund flows reached $71 billion over the third quarter. Bloomberg trade flow data confirms broker-dealers sold around $4.9 billion in corporate bonds over the quarter on a net basis. Despite strong gross issuance in the quarter, year-to-date net issuance remains negative, down -7.2 percent compared to 2018, as September saw $81 billion of bond redemptions and October redemptions are expected to top $60 billion. Inflated FX hedging costs stymied the shorter-dated buy programs in Asia, but domestic buy programs looking to park cash filled this void with ease. Foreign investors have been net buyers of long-dated corporate bonds for most of the year. This relatively steady stream of demand was complemented by traditional U.S. insurers and asset managers adding risk in the secondary market.
International Demand for Long-Dated Corporate Bonds Has Picked Up
Weekly Net Affiliate Buying of 12yr+ IG Corp Bonds (four-week moving average)
Foreign investors have been net buyers of long-dated corporate bonds for most of the year. This relatively steady stream of demand was complemented by traditional U.S. insurers and asset managers adding risk in the secondary market.
Source: Guggenheim Investments, TRACE, Bloomberg Barclays Indexes, Barclays Research. Data as of 10.4.2019.
We expect investment-grade corporate spreads to remain rangebound amid an abundance of caution. With investment-grade 10s/30s credit curves at the steeper end of the range and continued appetite from foreign and domestic buyers, we should see strong support for longer-dated, high-quality bonds.
Positive Spread Curve Supports Demand at the Long End
With investment-grade 10s/30s credit curves at the steeper end of the range and continued appetite from foreign and domestic buyers, we should see strong support for longer-dated, high-quality bonds.
Source: Guggenheim Investments, BofA Merrill Lynch Global Research. Data as of 9.30.2019.
Recession fears will also support front-end buying as investors wait for more clarity around the macroeconomic backdrop. Investors are conservatively positioned going into the end of the year, which further decreases the probability of corporate spreads widening. However, low all-in yields, spreads at the tighter end of the range, and potential funding spikes in December should limit the likelihood of material spread tightening. While investors are likely to play it safe in the fourth quarter, demand for investment-grade bonds should remain robust given the sector’s substantial 13 percent year-to-date performance on a total return basis.
—Jeffrey Carefoot, CFA, Senior Managing Director; Justin Takata, Managing Director
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